A fixed deposit is a type of savings account offered by banks. You deposit a certain amount of money for a fixed period, and the bank pays you interest on it. The money stays locked in during that time, and you earn a predictable return when the period ends. It's like putting your money away in a safe place to grow, but you can't access it until the agreed time is up.
Most people view a FD as:
- An investment scheme since they get a higher interest compared to savings account, and
- A place to park emergency savings
Here's what you need to know!
A FD is not really an investment product.
FD is essentially a deposit product (hint: it's even in the name - fixed deposit). And since it is a deposit, it is covered by the Deposit Insurance Scheme established by the government. This insurance serves to protect the deposits of customers placed in licensed Malaysian banks, so you are assured that your savings are secured.
When you open a fixed deposit, you agree to keep your money locked in
for a specific period, which can range from a few months to several
years. This commitment allows banks to plan and manage their funds more
effectively. In contrast, in a regular savings account, you can withdraw
your money at any time, making it less predictable for the bank. This is one of the reasons why a FD offers a higher interest rate compared to a regular savings account, even though they are both deposit products.
But aren't the rates attractive?
It is easy to find the FD rates from comparison websites such as RinggitPlus and LoanStreet. Some rates may look attractive due to special bank promotions, but it is good to understand the role that a fixed deposit plays in your cash management strategy.
The graph below shows the fixed deposit rate in Malaysia since 2015.
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| FD rates, source: DOSM |
Now, compare the above with the OPR rates in the graph below
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| OPR rates, source: DOSM |
Notice that the FD rate tracks very closely to the OPR rate? What this means in practical terms for you is that a FD basically just helps preserve the value of your money on par with inflation. And that is why it is not really an investment product. When you invest money, you are expecting to get capital appreciation, not capital preservation.
Is it good for emergency savings?
Keeping your emergency savings in FD can be better than keeping it in savings, because, as discussed above, it helps preserve the value of your money. If you were to keep your emergency cash in a savings account, then you are effectively eroding the value of your money due to inflation. But, importantly, FDs come with a fixed tenure, and this feature sort of contradicts the definition of an emergency. You have no idea when an emergency will occur. However with an FD, you need to decide how long you are willing to lock up your money and there is a penalty for early withdrawal should you suddenly need to withdraw it due to unforeseen circumstances. The penalty is simply that you lose all interest and in such a circumstance its no different from a savings account.
What are the risks associated with fixed deposits?
The risks associated with fixed deposits are generally low, but there are a few things to consider:
Low Returns: The interest rates on fixed deposits are often lower than potential returns from other investments like stocks or mutual funds. This means you might miss out on higher earnings.
Lack of Liquidity: Once you put your money in a fixed deposit, you usually can't withdraw it until the maturity period ends without facing penalties. This lack of liquidity can be a problem if you need immediate access to your funds.
Inflation Risk: Fixed deposit returns may not always keep up with inflation. If inflation rises, the purchasing power of your money could decrease over time.
Opportunity Cost: By tying up your money in a fixed deposit, you might miss out on better investment opportunities that could have provided higher returns. Read our explainer here to understand what opportunity cost means.
Bank Risk: Although fixed deposits are generally considered safe, there's still a risk if the bank itself faces financial trouble. It's essential to choose reputable and well-established banks for your fixed deposits.
Interest Rate Fluctuations: If you opt for a variable-rate fixed deposit, the interest rates may change during the tenure, affecting your returns.
Remember that fixed deposits are more suitable for short-term savings and preserving capital rather than generating substantial growth. It's always a good idea to diversify your investments to manage risk effectively.